Goldman on Nortel
Positive Mgmt Meetings - Reiterating Our Positive View
We hosted packed investor meetings yesterday with Sue Spradley, President of the
Wireline Networks division (22-25% of sales). As NT makes its first effort to place
business heads in front of investors since the accounting issues broke, the clear message is
that business is going well and thus far has not been impacted by the accounting issues. 3
points: #1 We walked away from the meetings encouraged that our gross margin analysis
is likely accurately calling for mid 40% (see our May 9, 2004 note). #2 We are
encouraged NT continues to gain incremental share in wireline. #3 Mgmt sees teleco and
cable competition heating up leading to spending on equipment, which supports a +
demand outlook. Below, greater details on the competitive landscape, cost issues,
opportunities. We reiterate our Outperform, noting it has higher risk compared to our
other OP rated stocks (Cisco, Juniper, Ericsson), and requires a longer-term view. Our
coverage view is Neutral.
UPSIDE / DOWNSIDE: In our opinion, valuation discounts much of the risk at hand and
is attractive relative to peers and historical levels - fair value of $5.50 to $6, we see
18-20% downside and 35-50% upside.
COSTS: Despite accounting issues, Mgmt understands the cost base of the business and is able to
price contracts and pursue business accordingly. Additionally, there is no further major cost cutting
ahead, but the company overall will continue to focus on gaining greater efficiencies.
We also walked away from the meetings with the view that within the wireline division sales could
grow with little need to increase opex. Specifically the division is past several major R&D
milestones on its VOIP product line and continues to steadily reduce investments in older circuit
switched technology.
The company is currently able to price below competitors on key products such as VOIP, as its
products have been in the market for several quarters compared to competitors such as Lucent who
are still acquiring parts of the product line. This lead to market has allowed them to come further
down the cost curve vs. peers and now serves as a competitive advantage.
DEMAND OUTLOOK BY REGION:
North America: Competition between traditional telcos and cable companies has picked up
considerably over the past 6 months. This is leading to a greater equipment demand, specifically
from cable VOIP and traditional telecos who are focused on broadband deployments. Nortel
benefits on both sides here, as a VOIP supplier to Cox and Comcast and a optics and data supplier
to many major telcos.
Europe: Traditional wireline telcos have been slower to move their networks to next generation
technology compared to their wireless peers. So much of Nortel's data business is related to the
ramp of 3G wireless networks where it is a major backbone provider to companies such as
Vodafone.
Asia Pac/China: Carriers are moving aggressively with a continued steady pace of new builds.
However local competitors to Nortel such as Huawei and ZTE are setting the pace. Local carriers
in China will not move forward on major builds without their local suppliers. Thus, Nortel
sometimes must wait for the local vendors to develop the needed technology. Beyond China,
carriers are not tied to these vendors and are moving relatively more aggressively toward new data
services.
VOIP LANDSCAPE: Nortel continues to win incremental share in every region. Sonus, Huawei,
and Siemens are the real competition at this point. Alcatel and Lucent continue to lag in terms of
product or ability to win beyond their installed base. Nortel has come down the cost curve to a
much greater degree compared to peers. For example Nortel's gateway product which can account
for 50-70% of a VOIP contract has been on the market shipping to customers for several quarters.
Lucent just recently acquired a gateway product through its Telica acquisition, and will now have
to invest R&D and ramp volumes to be on equal cost footing. |
